Accounting: Notes Receivable
Notes receivable, also known as promissory notes, are written pledges to pay a certain amount of money plus interest by a specified date in the future. The maker is the party that signs the note and will make payment in the future. The payee is the party that loans the money and is promised payment in the future. The principal is the base amount (excluding interest) loaned in a promissory note.
The formula for calculating interest is Principal × Interest rate × Time. The interest earned on a note receivable is classified as a revenue by the payee of the note, and the interest paid on a promissory note is classified as an expense by the maker of the note.
The maturity value is the total amount of a note to be paid back at the maturity date, including the principal and interest. The maturity date is the date when the final payment on a note must be made. The interest rate is the percentage of interest that will be applied every year. The interest period is the interval from the original date of the note to the date of maturity.
When a note is issued for a period of months, it comes due in the last month on the same day as when it was originally issued. When a note is issued for a period of days, the calculation of the maturity date should include the maturity date itself, but it should not include the date on which the note was issued.
The adjusting entry to record the interest revenue accrued on a note receivable at the end of the year would be a debit to Interest Receivable and a credit to Interest Revenue. The journal entry made on the maturity date of a note receivable, assuming both principal and interest are repaid at that time, would be a debit to Cash and credits to Notes Receivable, Interest Receivable, and Interest Revenue.
When the debtor fails to pay at maturity, it is called dishonoring the note. When the maker of a note fails to pay by the maturity date, the payee typically moves the amount due from Notes Receivable to Accounts Receivable. This requires a debit to Accounts Receivable and credits to Notes Receivable and Interest Revenue.